Newsletter Articles

New Trump Tax Laws Make 2019 The Best Year For Millions Of Americans To Do A Roth IRA Conversion

By: James Lange

Elder Law Associates Newsletter dated April 24, 2019

Ashlea Ebeling, a Forbes Magazine associate editor, contacted me about writing an article featuring a firm that proactively recommends Roth IRA conversions. Having worked with her years ago I knew that she had a strong background in finance, better than the vast majority of financial writers, and that she takes the time to get things right.  Seemed like a good fit. And it was.

The article, Thanks to Trump Tax Law, The Time is Ripe for this Roth Conversion Retirement Trick, is one of the articles featured on the cover of this month’s Forbes Magazine (February 28, 2019) in their “Investment Guide 2019—Keep Calm and Carry On.”  It has the coolest picture I have ever seen in any article taken by the award-winning photographer, Tim Pannell.  You can see the picture and read the article here.  The article was one of the editor’s “picks” and it received 50,000 hits the first day it ran.

Ashlea was delighted to learn that I wrote the first peer-reviewed Roth IRA conversion article back in 1997 and that I wrote a bestselling book on Roth IRA conversions, both of which she used for her research.  Her article couldn’t cover every detail of converting traditional IRAs to Roth IRAs, so, knowing that I was a Forbes.com contributor, she suggested I write a companion piece to the article.

The Forbes article focuses on Roth IRA conversions. Because of the Trump tax laws, more owners of traditional IRAs need to explore the potential benefits of a conversion—and that also applies to IRA owners who previous to the new tax laws explored the idea and dismissed it. Further, owners of traditional IRAs who were good candidates for a Roth IRA conversion before the tax reform may find that this is the best time for an even larger Roth IRA conversion.

Your traditional IRA has a silent partner named Uncle Sam.  Whenever you withdraw money from your IRA, voluntarily or because of minimum required distributions, your partner gets a big bite of every withdrawal.  A Roth IRA conversion essentially buys Uncle Sam out of your partnership through an up-front tax payment. The amount you convert is added to your current income and taxed at the appropriate rate, after which the money in the Roth IRA is all yours—no more taxes will be collected on the principal or on the growth.

See where I said the “appropriate rate”? That is the key. Because of today’s lower income tax rates—which are not likely to remain sustainable—now may be the opportune time to make a Roth IRA conversion.

Benefits Of A Roth IRA Conversion

Roth IRA conversions can leave you and your spouse better off by hundreds of thousands or even a million dollars during your own lifetimes, but those benefits pale in comparison to those that your children or grandchildren could enjoy over their own lifetimes.  Ashlea’s article ends with a quote from me about how I’d love to see my own Roth IRA grow tax-free for 100 years. Why?  Because a hundred years of tax-free compounding could leave my daughter and even my grandchildren millions upon millions of dollars better off.

If you are a long-term investor—particularly if you are someone who sees themselves as responsible for protecting and growing the family wealth, the “family stewards” so to speak, a Roth IRA conversion could benefit your heirs for generations to come.  So, let’s get into some of the nitty-gritty numbers that support that claim.  My wife, Cindy and I made a $239,000 Roth IRA conversion in 1998.  The following chart shows the benefit to my wife and me and our daughter Erica and our grandchildren.  This assumes 7% rate of return for actual dollars, and I also show the benefit in inflation adjusted dollars.

These numbers are based on the current tax laws, and they also assume no one ever spends my Roth IRA or the income my Roth IRA generates. The point is meant to be dramatic to catch your attention.

You might not think it is realistic nor even advisable that my heirs will not spend any of my Roth IRA.  But even if my daughter needs the money after I’m gone, my family will benefit by hundreds of thousands of dollars and, in the long run, could be more than a million dollars better off because of my conversion.

You may also think 7% is an unrealistically high rate of return I actually think you could do better for the reasons given below.  Subject to some exceptions, most of my clients plan on spending their Roth IRAs only after they run out of all other funds.  Then when they die, they will leave the Roth IRAs to their heirs who will hopefully allow the inherited Roth IRA to grow income-tax free for as long as possible.  What this means is that a Roth IRA, for most investors, produces better results if it is invested for the long run.

I like to think of dividing your portfolio in a number of buckets with each bucket invested differently.  The first bucket or money that you need to use in the short term for routine expenses should be invested very conservatively – with cash, CDs, maturing bond ladders, etc.  On the other end of the spectrum, the longest-term bucket is money that you plan to spend last and probably won’t ever spend unless all of your other resources are completely exhausted.  We treat Roth IRAs as part of your longest-term bucket.  Given that scenario, a 7% rate of return on a Roth IRA could be a conservative estimate.

The Best Time To Do A Roth IRA Conversion

Ideally, the best time to convert your traditional IRA to a Roth IRA is when you are in your lowest tax bracket and when the stock market is down. But no one has consistently predicted market highs and lows, and they don’t ring a bell at the bottom or top.    The good news is that you do know your current tax bracket and you can take your best estimate at your future tax brackets. Armed with that information, you can begin to build a Roth IRA conversion plan that is part of your master plan.

What should you do next? How do you know if a Roth IRA conversion would be a good idea for you? How much should you convert?  When is the best time to make the conversion?  Should you do it all at once or perhaps make a series of smaller Roth IRA conversions over a period of years?

Unfortunately, there’s no “one-size-fits-all” answer to those questions.  That’s why I recommend “running the numbers.”  “Running the numbers” involves constructing plausible scenarios using reasonable assumptions for your current and future tax brackets, your spending, earning, and investing patterns, and then testing different courses of action.  It is a combination of art and science.

The first projection may exclude all Roth conversions, which allows you to see where your finances will stand at the end of your life and what maintaining the status quo will mean for your heirs.   A second projection might use the same assumptions but show the outcome if you convert your entire traditional IRA to a Roth IRA in one tax year.  A third projection might include a series of partial conversions, perhaps over four years during the years after you retire, but before you turn age 70 when you will have minimum required distributions and will be receiving your full Social Security benefits. Taking the time to construct different scenarios is critical, because the best time to do a Roth IRA conversion is not the same for everyone.

One major consideration that is overlooked by many advisors is Social Security.  Ashlea correctly points out that the classic “sweet spot” to make a Roth conversion is after you retire but before age 70.  At that point, you won’t have income from your job or minimum required distributions from your retirement plans.  But I go so far as to recommend that the primary wage earner of the family delay applying for their full Social Security benefits until age 70—for reasons that I cover in an earlier post.   When planned and orchestrated, all of these factors can come together in a perfect symphony of financial opportunity, leaving your income tax bracket at an all-time low, and cued-up for a Roth IRA conversion.

An additional benefit of “running the numbers” is that you may find you are not a good candidate for a Roth IRA conversion.  Many IRA owners will have higher Medicare Part B premiums if their taxable income is increased because of a Roth conversion.  Other IRA owners will suffer a reduction in the benefits of the qualified dividend exclusion, and others will face additional tax in the investment income area.  Many of these disadvantages may pale compared to the benefits, but the only way to know is to run the numbers first.

Ultimately, the new tax laws mean that Roth IRA conversions can benefit many more people even before retirement or who are currently in retirement.  This is because, if you are married and file a joint return, you can have up to $315,000 in taxable income and still fall within the expanded 24% tax bracket.  Many taxpayers who are still working, or who are over age 70 but previously sat in a high enough tax bracket to make a Roth IRA conversion unprofitable, may now find that this is the best possible time to make the change. This is especially true if you believe tax rates are likely to increase in the future.

So, what is the big take-away? It would be a smart move for many taxpayers to analyze the merits of a Roth IRA conversion. And, if previously you determined that a Roth IRA conversion was not in your best interest, you should probably revisit the idea—times have changed.

Let’s be clear. This isn’t just about dying with the most money—you must also evaluate your priorities.  One of the benefits of creating a master plan is to determine how much you can safely spend, and with a very high probability that you will never run out of money.  Perhaps it won’t matter to you that your heirs could be a million dollars better off because you want to spend more money yourself.  Perhaps you want to buy a second home in your dream location even if, God forbid, you have to use part of your Roth IRA to do it.   These are personal decisions and each piece needs to fit into your retirement and estate planning puzzle. Roth IRA conversions, although financially beneficial for many people, are only one piece of puzzle.

This is a complicated topic, but an important one. Watch for a follow-up post from me that will show you how Roth IRA conversions can help you with your long-term estate planning goals.

Article Source: Forbes.com